Why Use a Solo 401k Plan instead of a Self-Directed IRA?

Last Updated: 10/19/2022

It makes more sense to Open Solo 401k (also known as Self-Directed Solo 401k or Individual 401k) over a Self-Directed IRA in all cases except two, which we will discuss later.  For now we will detail why Solo 401k easily trumps the self-directed IRA.

Solo 401k allows for higher annual contribution 

Solo 401k allows for higher annual contribution limits then self-directed IRA. For instance, for 2022 the owner-only business owner can contribute $61,000 and an extra $6,500 if age 50 or older (know as catch-up contribution) for total possible contribution of $67,500. On the other hand, the self-directed IRA maximum contribution for 2022 is $6,000 or $7,000 if you include the $1,000 catch-up amount. Visit Solo 401k Contribution Limits to learn more.

Solo 401k allows for higher Roth Contributions

For 2022 the self-employed business owner can contribute up to 27,000 to Roth Solo 401k. Specifically, $20,500 if under age 50 and an additional $6,500 if age 50 or older. The maximum Roth contribution for a self-directed IRA (Roth IRA) in 2022 is only $6,000 plus catch-up amount of $1,000.  Visit Roth Solo 401k to learn more.

Solo 401k allows for Participant Loan (borrow from Solo 401k)

If you borrow from your Self-Directed IRA, it will be deemed a taxable distribution. However, the owner-only business owner can borrow from his or her Solo 401k through what is known as a Solo 401k Participant Loan without having to pay distribution taxes or penalties. The maximum Solo 401k Loan amount is 50% of the participant’s solo 401k balance not to exceed $50,000.  The minimum Solo 401k Loan amount is $1,000 and multiple loans are allowed, you just can’t exceed the mentioned maximum limit when combining all Solo 401k loans.Visit Solo 401k Loan to learn more.

You can serve as Trustee of your own Solo 401k

The rules permit the business owner to Trustee his Solo 401k assets, meaning that you don’t have to use the services of a custodian to hold/safe keep the Solo 401k investments.  As a result, holding and investment processing fees are greatly reduced or completely eliminated, and processing times greatly reduced since you don’t have to submit investment processing directions to the custodian.  While a self-directed IRA has option of forming an LLC to reduce custodian involvement, the custodian ultimately has control over the self-directed IRA pursuant to IRS regulations. Therefore, the self-directed IRA participant will ultimately pay higher investment and processing fees when compared to the Solo 401k which does not require a custodian.

Solo 401k is not subject to UDFI

Unlike a Self-directed IRA which is subject to payment of unrelated business income tax when it utilizes debt financing to invest in real estate, a Solo 401k is generally not subject to payment of UDFI when it incorporates a nonrecourse loan to invest in real estate.  To learn about UDFI, visit Solo 401k UBIT. To learn about Nonrecourse loan, visit Solo 401k Nonrecourse Loan.

Solo 401k may not be subject to annual reporting

A self-directed IRA is subject to annual reporting (Form 5498) regardless of account value, whereas a Solo 401k may not be subject to annual reporting.  Solo 401k only requires filing of Form 5500 EZ once the total account value exceeds $250,000 and when you terminate the Solo 401k.  Visit Form 5500 EZ to learn more.

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>


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